ACCT 152 Chapter 6

Keys to Segmented Income Statements:

- a contribution format should be used because it separates fixed from variable costs and it enables the calculation of a contribution margin - traceable fixed costs should be separated from common fixed costs to enable the calculation of a segment margin

Inappropriate Methods of Allocating Costs Among Segments:

- failure to trace costs directly - inappropriate allocation base

common costs should not be arbitrarily allocated to segments based on the rationale that "someone has to cover the common costs" for 2 reasons:

- this practice may make a profitable business segment appear to be unprofitable - allocating common fixed costs forces managers to be held accountable for costs they cannot control

3 Key Concepts:

1. Both variable and absorption costing income statement formats include product costs and period costs, although they define these cost classifications differently 2. Variable costing income statements are grounded in the contribution format - they categorize expenses based on cost behavior - variable expenses are reported separately form fixed expenses - absorption costing income statements ignore variable and fixed cost distinctions 3. Variable and absorption costing net operating income figures often differ from one another - the reason for these differences is due to the fact that variable costing and absorption costing income statements account for fixed manufacturing overhead differently

both U.S. GAAP and IFRS require publicly traded companies to include segmented financial data in their annual reports:

1. companies must report segmented results to shareholders using the same methods that are used for internal segmented reports 2. this requirement motivates managers to avoid using the contribution approach for internal reporting purposes because if they did they would be required to: - share this sensitive data with the public - reconcile these reports with applicable rules for consolidated reporting purposes

absorption costing

a costing method that includes all manufacturing costs - direct materials, direct labor, and both variable and fixed manufacturing overhead - in unit product costs

variable costing

a costing method that includes only variable manufacturing costs - direct materials, direct labor, and variable manufacturing overhead - in unit product costs

traceable fixed cost

a fixed cost that is incurred because of the existence of a particular business segment and that would be eliminated if the segment were eliminated

common fixed cost

a fixed cost that supports more than one business segment, but is not traceable in whole or in part to any one of the business segments

segment margin

a segment's contribution margin less its traceable fixed costs; represents the margin available after a segment has covered all of its own traceable costs

Variable vs. Absorption Costing

absorption costing - fixed manufacturing costs must be assigned to products to properly math revenues and costs variable costing - fixed manufacturing costs are capacity costs and will be incurred even if nothing is produced

segment

any part or activity of an organization about which managers seek cost, revenue, or profit data

under variable costing, only those manufacturing costs that vary with output are treated as product costs - direct materials - direct labor - variable portion of manufacturing overhead

fixed manufacturing overhead is not treated as a product cost under this method - is instead treated as a period cost and is expensed in its entirety each period

fixed costs that are traceable to one segment may be a common cost of another segment

for example, the landing fee paid to land an airplane at an airport is traceable to the particular flight, but it is not traceable to first-class, business-class, and economy-class passengers

both U.S. GAAP and IFRS require absorption costing for external reports

since absorption costing is required for external reporting, most companies also use it for internal reports rather than incurring the additional cost of maintaining a separate variable cost system for internal reporting

the segment margin represents the margin available after a segment has covered all of its own costs

the segment margin is the best gauge of the long-run profitability of a segment because it includes only those costs that are caused by the segment

when unit sales exceed the units produced and hence inventories decrease, net operating income is lower under absorption costing than under variable costing

this occurs because some of the fixed manufacturing overhead of previous periods is released from inventories under absorption costing

when the units produced exceed unit sales and hence inventories increase, net operating income is higher under absorption costing than under variable costing

this occurs because some of the fixed manufacturing overhead of the period is deferred in inventories under absorption costing

in absorption costing, fixed manufacturing overhead costs are included as part of the costs of work in process inventories

when units are completed, these costs are transferred to finished goods and only when the units are sold do these cots flow through to the income statement as part of cost of goods sold